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1. Apply key International Financial Reporting Standards (IFRS) requirements and evaluate given accounting treatments for compliance with IFRS.
2. Provide explanations, in a *professional context, for current accounting practice in accordance with International Financial Reporting Standards. (IFRS).
3. Prepare elements of single- entity financial statements and provide explanations of current accounting practice in accordance with IFRS.
4. Construct consolidated financial statements for a group of companies, including associates and joint ventures.
Professional context: Provide explanations as required relating to the financial information prepared in a clear and concise manner, applying professional communications skills. I.e. producing a document in the correct format, producing explanations appropriate to the audience and using good business language.
You are the newly appointed head of the finance team for JJ Victory Plc (JJ Victory) The finance department is responsible for the preparation of the single entity Financial Statement for JJ Victory as well as the Consolidated Financial Statements for the Group.
JJ Victory is a manufacturer of luxury high performance motorbikes and the sale of parts and servicing of motorbikes. As at 30 September 2018, the company has 4 core models which are hand built and distributed through a network of franchised retailers.
The Company also provides high specification, ‘build to order’ motorcycles. These units can take between 3 months to a year to design and build to customer specifications. The unique nature and prestige attached to a JJ Victory ‘made to order’ motorcycle means that a significant premium can be charged for these units.
JJ Victory brand is highly regarded. Its hand built motorcycles are world renowned for style and quality. The brand value was seen to be greatly enhanced in the 1960’s when one of its bespoke models featured in a successful film franchise adapted from a well-known series of novels ‘Phantom Rider’. The company’s product continues to be featured in the ‘Phantom Rider’ franchise whose films continue to be box office hits.
JJ Victory’s strategy is to maintain and enhance its position in a niche market within the Motorcycle industry. The Board of Directors are aware that even though the JJ Victory brand is solid, it caters to a very narrow customer base only accessible to those with a significant amount of disposable income. The company wish to raise their profile and appeal to a younger market who tend to be more environmentally conscious. At present, JJ Victory’s customers are primarily in the age range 40 to 60 years.
Two strategies implemented during the year ended 30 September 2018 are:
1. Development of the company’s entire product line to lessen their engine’s harmful emission without the compromising on performance. This has been an ongoing activity for the JJ Victory’s research and development team with each new model introduced over the last 5 years producing less emissions. With a view to accelerate the progress on the development of the ultimate ‘clean’ engine, on 1 January 2018, JJ Victory purchased a 60% interest in DAC Enviro Ltd. (DAC).
DAC designs and produces engines for various manufacturers in the motor industry. The specialised nature of JJ Victory’s product line means that they have always hand built their own engines so DAC has not been one of their suppliers, however this new acquisition has led to some trading between the companies. DAC has, in recent years been involved in the development of engines which utilise alternative fuel technology. In 2016, DAC developed a dual fuel engine for small vehicles with increased utilisation efficiency of electric power, so reducing the use of petroleum based fuel to 50% of any other product on the market. DAC are currently developing a high performance sports engine that is exclusively electrically powered. The investment in DAC was made in order for JJ Victory to benefit from the expertise within the company and so progress further towards the company’s ultimate goal of having its entire range of motorcycles 100% electrically powered.
2. In the last 2 years, JJ Victory in partnership with Blast Plc (Blast!) has been developing a Moto GP chassis and engine, recruiting experienced Moto GP engineers and test riders with a view to setting up a competitive Moto GP team capable of winning races within a 3 year timeframe. Blast is a market leading energy drinks company but is well known for its involvement in and sponsorship of ‘extreme sports’ events. The agreement between JJ Victory and Blast is that Blast provides funding and JJ Victory is responsible for the development and build of the racing motorcycles. The Moto GP team is called ‘Blast 2 Victory’ or B2V. B2V is structured as a separate entity with 1 million shares in issue. The shares are allocated to JJ Victory and Blast in the ratio 40:60.
During the year ended 30 September 2018, B2V took part in its first racing season and whilst not winning any races, performed well in its maiden racing season.
Further information about this investment is contained in section 2 of the additional information (note 8).
The Financial statements of JJ Victory, DAC and B2V are shown below for the year ended 30 September 2018. The financial statements for all three companies were prepared prior to your taking on the role of head of finance of Finance of JJ Victory Group.
The statements for DAC and B2V have been authorised by the respective board of directors, however JJ Victory’s statements are draft financial statements.
Statement of profit or loss for the period ended 30 September 2018
|
Note |
JJ Victory (Draft) |
DAC |
B2V |
|
|
£’000 |
£’000 |
£’000 |
||
|
Revenue |
850,233 |
66,000 |
10,553 |
|
|
Cost of Sales |
(490,760) |
(31,800) |
(9,812) |
|
|
Gross profit |
359,473 |
34,200 |
741 |
|
|
Distribution and administrative expenses |
(211,063) |
(14,760) |
(992) |
|
|
Investment income (dividend from DAC) |
3,600 |
- |
||
|
Finance costs |
(24,311) |
(2,950) |
(232) |
|
|
Profit before tax |
127,699 |
16,490 |
(483) |
|
|
Income tax expense/credit |
(15,574) |
(1,525) |
38 |
|
|
PROFIT FOR THE YEAR |
112,125 |
14,965 |
(445) |
Statement of financial position as at 30 September 2018
|
Note |
JJ Victory (Draft) |
DAC |
B2V |
|
|
£’000 |
£’000 |
£’000 |
||
|
Non-current assets: |
||||
|
Property, plant and equipment |
257,567 |
13,735 |
7,972 |
|
|
Intangible assets |
910,705 |
52,060 |
23,700 |
|
|
Investment in DAC |
4 |
30,000 |
- |
- |
|
Investment in B2V |
8 |
10,000 |
- |
- |
|
1208,272 |
65,795 |
31,672 |
||
|
Current assets: |
||||
|
Inventories |
78,785 |
3,556 |
3,442 |
|
|
Trade receivables |
67,327 |
2,970 |
934 |
|
|
Contract costs |
2 |
220 |
||
|
Cash and cash equivalents |
102,572 |
133 |
21 |
|
|
248,904 |
6,659 |
4,397 |
||
|
Total assets |
1457,176 |
72,454 |
36,069 |
|
|
Equity and reserves: |
||||
|
Share capital (£1 nominal value equity shares) |
4,000 |
1,300 |
1,000 |
|
|
Share Premium |
10,000 |
1,200 |
32,500 |
|
|
Retained earnings |
625,434 |
43,994 |
(6,031) |
|
|
639,434 |
46,494 |
27,469 |
||
|
Non-current liabilities |
||||
|
Bonds |
750,000 |
23,850 |
5,300 |
|
|
Current liabilities: |
||||
|
Trade and other payables |
52,500 |
1,710 |
2,800 |
|
|
Borrowings |
15,242 |
400 |
500 |
|
|
67,742 |
2,110 |
3,300 |
||
|
Total Equity and liabilities |
1457,176 |
72,454 |
36,069 |
1. JJ Victory transfers motorcycles to it franchised retailers under the following terms:
As at 30 September 2018, motorcycles with a sales price of £62 million have been transferred to the retailers which have not been sold on to third party customers. JJ Victory has ecognised the revenue for these units at the point of elivery to the retailers in the draft Profit or Loss for the year ended 30 September 2018, along with the associated production costs within cost of sales. The production cost of the motor theses motorcycles is £35.3 million.
2. As at 30 September 2018, there is one ‘build to order’ motorcycle contract in progress. The contractually agreed sales price is £500,000 and estimated total costs for the completed motorcycle is £270,000. Costs incurred to date of £220,000 is recognised in the draft financial statements as contract costs within current assets.
The contract commenced on 1 June 2018 and estimated completion date is 1 November 2018. The terms of the contact stated that payment for the Motorcycle is made in 2 equal instalments of £250,000. The first of these payments has been invoiced as a trade receivable and the cash received by the year end.
In order to protect both parties, the contractual terms include that the customer will take ownership of major components when they are certified as complete by an independent engineer. As at 30 September 2018, the Chassis, engine and engine management system is certified as complete and the customer has legal ownership of these components. The customer is contractually responsible for the storage and insurance costs of these parts.
JJ Victory’s policy is to measure the progress of this type of contract in line with value of output. The company’s specialist engineers have deemed the project to be 70% complete.
In the draft financial statements of JJ Victory, the £220, 000 costs have been recorded as contract costs in current assets and the £250,000 invoiced to the customer has been recorded as a sale on credit. The balance on trade receivable for this amount is nil as the customer has paid the £250,000 by the year end.
3. On 1 October 2017, JJ Victory installed a new Production line. The cost of the production line was £10 million and this was the amount was capitalised as property plant and equipment. The factory floor needed some modification in order to facilitate the new line so site preparation costs £1 million were incurred. There was also a £500,000 installation cost. The estimated useful life of the production line is 10 years with no residual value, however, the line includes a significant component valued at £300,000 which will require replacement in 3 years.
The site preparation costs and installation fees were expensed to distribution and administrative expenses.
There has been no adjustment for the depreciation of this asset as, even though it is ready for use, it is only running at 25% capacity.
JJ Victory’s policy is to charge depreciation on production equipment to cost of sales.
Investments in other entities
4. Victory JJ acquired 60% of the equity shares of DAC on 1 January 2018. The retained earnings of DAC at acquisition were £32.8 million.
Further investigation into the contracts drawn up on purchase has revealed that the consideration for the investments were contractually agreed as follows:
Investment in DAC Ltd.
Cash (paid) £30m
Contingent consideration £10m
Deferred consideration £15m
The contingent consideration is to be paid if the efficiency and emissions test results of an engine development project achieve set targets. On the acquisition date, it was deemed likely that this condition would be met. Payment of the contingent consideration is to be made on 1 January 2020.
The deferred consideration of £15m is also be paid on 1 January 2020. There are no conditions attached to this payment.
6. A due diligence exercise was carried out on the acquisition of DAC. The report has revealed the following.
(i) DAC has land with a fair value of £5 million. This land is included in the financial records of DAC on 1 January 2018 and at the year end at its cost value of £3 million. There had been no change to the fair value of the land by 30 September 2018.
(ii) DAC undertakes a significant amount of research and development activities. A current project to develop a high performance electrically powered engine is progressing well however due to uncertainty over the availability of adequate resources to complete the project, DAC has not capitalised the costs relating to this project. The due diligence report includes a valuation for the research at £12 million. This valuation has been undertaken by a reputable firm who specialises in the valuation of technological developments in the engineering sector. The fair value of the research remains at £12 million on 30 September 2018.
(iii) The notes to the financial statements for DAC include disclosure of a contingent liability for a legal claim made by one of DAC’s customers brought on 1 August 2017. The claim states that engines purchased from DAC used substandard materials and this resulted in the need to rebuild some vehicles. It is alleged that the lost production time cost DAC’s customer £10 million and are claiming this amount as compensation. No amount has been provided in the financial statements of DAC with respect to this as in the opinion of DAC’s legal representation, it is not probable that the customers claim will be successful. The notes to Dac’s financial statements includes disclosure of a possible outflow of £10 million and the probability of outflow to be 30%.
As such, the due diligence report includes a fair value for the potential claim to be £3 million. The fair value of the contingent liability remains at £3 million on 30 September 2018. The claim is expected to be resolved within 12 months.
7. On 12 August 2018, DAC sold some engines to JJ Victory for £2 million on credit terms. The goods cost DAC £1.1 million to manufacture. On 30 September 2018, 70% of these engines have been used in JJ Victory’s motorcycles which have all been sold to their franchised retailers. These retailers are business entities outside JJ Victory Group.
On 28 September 2018, JJ Victory paid £1.6 million of the amount owed for the engines and reduced its trade payables balance accordingly. DAC has not yet received the funds and so its balance on trade receivables for JJ Victory remains at £2 million.
8. The net assets of B2V were at their fair value when JJ Victory acquired its 40% interest in the 1 million, £1 ordinary shares in the company on its incorporation. B2V was incorporated in October 2015 when JJ Victory invested £10 million in the enterprise. The other major investor, Blast!, invested £12million as well as transferring some Land and facilities for a 60% interest in the 1 million (£1) issued share capital. The contractual provisions for the joint arrangement provided that any significant financial or operational decisions required agreement of both parties and that any gains or losses of the entity (B2V) were to be shared in the ratio 40:60 for JJ Victory and Blast! Respectively.
9. Goodwill is tested for impairment each year end. The value of shares in both DAC and B2V have increased significantly in the year to 30 September 2018. There is therefore no impairment of any recognised goodwill of DAC or investment in B2V.
10. Profits or losses for all 3 companies accrue evenly throughout the year.
11. Although B2V have not made any profits since it was set up in 2015, the team, hence the company is well regarded within the MOTO GP community. The Motorcycles used in the most recent racing season contained innovations that are transferrable to retail market. The development team at B2V are known to be of the highest calibre and this greatly benefits the company’s reputation. The engineers have standard employment contracts.
On 1 October 2017, B2V negotiated a 3 year contract with Jasminder Rai.
12. Jasminder had been on the professional racing circuit for only 3 years and showed real promise. Since signing with B2V, her reputation as a talented motorcycle racer has grown. Jasminder has also attracted a great deal of press attention as one of only a handful of female motorcycle racers.
13. One of the junior members of your finance team, Michael, has attempted to prepare the consolidated financial statements for JJ Victory. Michael has used the draft financial statement of JJ Victory when preparing the group accounts. This is the first time that consolidated financial statements are prepared for the group as the investment in DAC was the first investment in a subsidiary made by the company.
The draft consolidated financial statements prepared by Michael team along with associated working papers are shown below:
JJ Victory Group – consolidated statement of Profit or loss for the period ended 30 September 2018
|
£’000 |
|
|
Revenue |
916,233 |
|
Cost of Sales |
(522,560) |
|
Gross profit |
393,673 |
|
Distribution and administrative expenses |
(225,823) |
|
Investment income (dividend from DAC) |
3,600 |
|
Finance cost |
(27,261) |
|
Profit before tax |
144,189 |
|
Income tax expense |
(17,099) |
|
PROFIT FOR THE YEAR |
127,090 |
|
Profit attributable to: |
|
|
Shareholders of JJ Victory Plc. |
121,104 |
|
Non-controlling interest (W3) |
5,986 |
|
127,090 |
JJ Victory Group – consolidated statement of financial position as at 30 September 2018
|
£’000 |
||
|
Non-current assets: |
||
|
Property, plant and equipment (257,567 + 13,735) |
271,302 |
|
|
Intangible assets (910,705+52,060) |
962,765 |
|
|
Goodwill (W5) |
8,820 |
|
|
Investment in B2V |
10,000 |
|
|
1,252,887 |
||
|
Current assets: |
||
|
Inventories (78,785+3,556) |
82,341 |
|
|
Trade receivables (67,327+2,970) |
70,297 |
|
|
Contract costs (220 +0) |
220 |
|
|
Cash and cash equivalents (102,572+133) |
102,705 |
|
|
255,563 |
||
|
Total assets |
1,508,450 |
|
|
Equity and reserves: |
||
|
Share capital (£1 nominal value equity shares) |
4,000 |
|
|
Share Premium |
10,000 |
|
|
Retained earnings (W7) |
632,150 |
|
|
Equity attributable to shareholders |
646,150 |
|
|
Non-Controlling interest (W6) |
18,598 |
|
|
Total equity |
664,748 |
|
|
Non-current liabilities (750,000+23,850) |
773,850 |
|
|
Current liabilities: |
||
|
Trade payables and other payables (52,500+1,710) |
54,210 |
|
|
Borrowings (15,242 +400) |
15,642 |
|
|
69,852 |
||
|
Total Equity and liabilities |
1,508,450 |
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